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UK Second-hand software – hidden opportunity or false economy?

Experts in IP law Conor Ward and Tom Wood explore the murky world of second-hand software

Conor Ward & Tom Wood, Computing 26 Nov 2009

Until the green shoots of economic recovery grow considerably greener, UK businesses face an ongoing need to find new cost-cutting opportunities. The IT department is no exception. Could buying and selling software second-hand be such an opportunity?

The bright idea

From a commercial angle, dealing in second-hand software (if legal) sounds a bright idea, whether it involves selling off unwanted software licences or buying additional licences at a discount.

Particularly in large organisations, keeping track of what volumes of licences are needed can be difficult. If the business has downsized during the current recession, it may have a surplus of expensive, unwanted licences. If businesses can sell on the licences without the involvement of the software owner, this is a way to unlock the value that the licences represent.

Equally, businesses might be tempted to save money by buying additional licences second-hand. This is possible: organisations can buy direct from the original purchaser or from specialist broker companies that are trying to tap into the market for second-hand software –­ see for example www.discount-licensing.com.

But are there legal risks associated with this?

The problem of the licence

Typically, manufacturers’ standard licence terms tend to restrict their customers’ ability to transfer the licence ­ – and therefore a copy of the software ­ – to another party. This means that selling unwanted software to anyone else will often be in breach of the licence terms. The manufacturer can then say that the recipient is not properly licensed. If that is correct, the recipient will be infringing the copyright of the software manufacturer by using the software, while the person who sold the licence on could be liable for breach of the licence terms.

Court cases

The conflict between the exhaustion principle and manufacturers’ software licence terms has led to a diversity of judicial opinions. Unfortunately there are virtually no helpful English decisions.

Germany has taken the lead in tackling the question, but the decisions of the German courts have not been consistent. Some decisions have supported the principle of software resale, regardless of whether software was downloaded or purchased on a physical medium, such as a CD. But in a German case running from 2006-2008 involving downloadable Oracle software, the court repeatedly held that the exhaustion principle should not apply to allow the resale of mere licence keys, as opposed to software embodied on some form of physical data carrier.

The issue is equally controversial outside of Europe. In the US, there is an equivalent to the exhaustion principle known as the “first sale doctrine”. In a September 2009 decision, a judge in Washington upheld the right of a trader to sell on eBay second-hand copies of computer-aided design software.

However, the judge was relying on a number of conflicting regional court decisions. Commentators hope that the decision will be appealed to a federal court and thus the position will be clarified for all US software houses and their customers.

Conclusion

There is still a lack of clear legal guidance on how the exhaustion principle relates to conflicting licence terms, especially in the UK. In other territories there are more cases but still no consensus among judges or legal commentators on the correct way to resolve the issue. There remains a fundamental tension between IP rights –­ which restrict trade but promote innovation ­ – and the ability to trade goods freely.

The original method of distributing the software seems to be of particular importance. In cases where the right to resell has been argued successfully before the courts, the fact that the software was originally distributed on a physical medium seems to be significant to the court, whereas software downloaded from a licensor’s web site using codes or keys that have been resold appears to find less favour.

That the application of the exhaustion principle should turn on an arbitrary point relating to distribution medium seems harsh. A well-argued case put before the correct judge may put the debate to bed, but only if the vendor is prepared to fight this battle in court.

While not for the weak-hearted, the sale and purchase of second-hand software appears to be here to stay, at least until a court decision rules it definitively unlawful. Software developers may take legal action to stifle it, but in doing so risk legal challenge and the EU authorities investigating their licensing and distribution policies.

Conor Ward is a partner and Tom Wood an associate in the Intellectual Property Media & Technology practice at law firm Lovells LLP

Either way, the manufacturer will want somebody to pay for a new licence, and the perceived benefits of second-hand software will evaporate. But this is not the end of the story.

The European exhaustion principle

What complicates the position ­ – and also offers some hope for those who want to see a flourishing market in second-hand software –­ is the European legal principle of the exhaustion of rights.

One of the founding principles of the EU is that “goods” should be freely in circulation and tradable within Europe. Unfortunately, this creates an inherent tension with the concept of copyright and other intellectual property (IP) rights.

The purpose of IP, of course, is to allow creative entities, such as software developers, to profit from their creativity. The law gives IP owners certain monopoly rights to prevent others dealing freely with their IP.

So the principle of exhaustion of rights was developed by European courts in the 1970s as a way of balancing the competing interests of free trade and IP owners.

The exhaustion principle applies generally to all types of IP –­ including for example patented inventions as well as copyright works such as computer programs, music recordings and DVDs.

The exhaustion principle recognises that the legal rights granted to the IP creator are designed to compensate them for the time and money spent in creating the IP. Where the exercise of the IP right can result in the production of a material object such as a CD, the owner at first can control the production by making the object directly or by licensing another to do so. In either case the copyright owner can extract adequate compensation on the occasion of the “first sale” with his consent of the product in the territory offering the IP protection.

However, after this first sale, under the exhaustion principle, the product can then be freely sold in the territory of that state, and often throughout E urope. The owner cannot rely on his IP right to prevent resale of the product. In other words, after the authorised first sale, the owner of the IP right has “exhausted his rights” in the product.

The exhaustion principle is explicitly applied to software in the EU Software Directive. The directive states that the first sale in the European Community of a copy of a computer program by the IP rights holder (or with his consent) shall exhaust “the distribution right” within the Community of that copy. The distribution right means the right to distribute (ie to sell) that copy to a customer. However, this will often conflict with the manufacturer’s licence terms prohibiting resale of the software.

A further complicating factor is that the exhaustion principle was created with physical objects in mind, such as books, tapes and CDs. But as software is increasingly downloaded, or accessed remotely in the cloud, or via other online services, there may be no tangible object to which the principle can be applied.

The less easy it is to identify the physical copy that was sold, the less easy it becomes to argue that the exhaustion principle applies. Manufacturers can argue that users are not buying a product or object at all, but merely a licence to use the software.